What's The Keystone XL Debate All About Anyway?

Addressing the two sides of the debate about the Keystone XL pipeline and the companies most heavily affected by its outcome.

On Friday, the U.S. Senate gave the controversial Keystone XL pipeline its stamp of approval by passing a measure introduced by a Republican senator.

The measure, introduced by Sen. John Hoeven of North Dakota as an amendment to this year's budget resolution, passed by an overwhelming 62 to 37 vote, in a largely symbolic victory that suggests Congress is likely to approve the Keystone project later this year.

Though the Senate's approval is the most recent boost to the proposed Keystone XL pipeline, other federal bodies have also concluded in its favor. A recently released U.S. State Department study cast an overwhelmingly favorable light on the project, arguing that its construction would confer major economic benefits to the U.S., without posing severe environmental risks.

But environmental groups and climate change campaigners – clearly unconvinced by the State Department report – are not happy. Despite these setbacks, they continue to gain strength in deterring the pipeline's construction, as evidenced by the rising number of protestors turning up at recent anti-Keystone events.

As we move closer to President Barack Obama's decision, which is expected by the end of summer, the big debate about Keystone continues to heat up. Which side will emerge victorious? And which companies will be affected by its outcome? Let's take a closer look.

The State Department's viewAccording to the State Department study, Keystone's environmental impact would not be nearly as bad as several environmental groups claim and its construction would have just a marginal impact on greenhouse gas emissions.

In fact, the study finds that rejecting Keystone would have only a negligible impact on oil sands output, which it estimates to be between 0.4%-0.6% by 2030. It further finds that, even if all new pipeline capacity from Alberta was blocked, oil sands production would fall by just 2%-4%, since energy companies can transport oil using alternative methods such as rail and barge.

Environmentalist oppositionBut environmentalists remain unconvinced. Rejecting the notion that development in Canada's oil sands would continue unabated irrespective of Keystone's construction, they continue to oppose the pipeline on the grounds that it would boost greenhouse gas emissions to dangerously high levels.

This is because production in Alberta's oil sands – also known as tar sands – involves the extraction of an extremely heavy, viscous type of bituminous crude oil. Producing this type of oil, which requires high levels of capital investment and carries significantly higher production costs per barrel, is thought to spew much greater quantities of greenhouse gases into the atmosphere than alternative forms of crude oil production.

Keystone's impact on producers of oil sands and U.S. refiners You can bet that the debate about Keystone is being followed closely by U.S. refiners, many of which are eager to gain improved access to Canadian oil sands crude, and by the oil sands producers themselves, many of whom are struggling due to heavily discounted prices for their product.

Even Suncor(NYSE:SU), one of Canada's biggest energy producers, wasn't immune from the negative financial impact of low prices for oil sands crude. In the fourth quarter, the average price the company received for its oil sands output plunged to $77.37 per barrel, down markedly from $98.02 in the year-earlier period. In combination with a write down of nearly $1.5 billion related to its Voyageur project, depressed prices pushed the company to a quarterly loss of $562 million.

Though Keystone would help bring Canadian crude prices closer in line with other North American crude oil benchmarks, thereby alleviating Suncor and other oil sands producers' woes, U.S. refiners have found ways to temporarily surmount the hurdle of limited pipeline capacity.

For instance, Tesoro(NYSE:TSO) is investigating ways to ship oil sands crude to the U.S. Pacific Northwest via barge, while Valero(NYSE:VLO) is expecting to boost its use of rail and barge to move Canadian crude to its Gulf Coast refineries. And Phillips 66(NYSE:PSX) recently said that it is now delivering Canadian crude to its California refineries via rail.

While the increased usage of rail and barge adds some credence to the State Department's claims that production in Canada's oil sands would continue largely unabated with or without Keystone, few would deny that the pipeline's construction would be a net positive for Alberta's struggling producers.

Yes or no to Keystone?Personally, I think Keystone XL should be given the green light. This is not because I think environmentalists' concerns are unfounded; I wholeheartedly agree that we shouldn't risk raising the Earth's temperature by more than 2 degrees Celsius – the generally accepted threshold level that, if breached, could lead to more of the previously unthinkable weather events that have become commonplace over the past couple of years.

But as the State Department study argues, rejecting Keystone is unlikely to have a meaningful impact on the future pace of development in Canada's oil sands and, therefore, on the level of greenhouse gas emissions released by Alberta's producers. And it certainly wouldn't reduce U.S. Gulf Coast refiners' thirst for Canadian crude – a grade of oil well suited for many of their facilities.

So if Alberta's producers are going to keep drilling regardless of new pipelines, why should we forgo the short-term economic benefits and medium- to longer-term energy security Keystone would provide?

Final thoughtsAt any rate, I think the debate over Keystone overshadows a bigger, more important discussion about the future of global energy. Yes, Keystone would create tens of thousands of jobs during its construction period. And, yes, it would improve our energy security by providing greater reliability of fuel supply for several years. But what happens after that?

We can't expect to break our decades-old addiction to oil and other fossil fuels overnight. Solving the global energy challenge will require long-term investment in alternative energy sources and structural improvements that incent private firms to pursue the development of such technologies – a goal that too often takes a back seat to the "drill baby drill" rhetoric, especially with the euphoria surrounding our newly economical shale oil and gas reserves.

We shouldn't lose sight of the fact that new reserves can only sustain our addiction to fossil fuels for a finite period of time, which evidence suggests may be shorter than commonly believed. Instead of patting ourselves on the back and taking a breather, we might be better off viewing our vast shale resources and Canada's oil sands as a temporary blessing, and instead work extra hard to develop the alternative energy sources that will replace those reserves once they eventually and inevitably run dry.

Author

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.